Inflation…. how it’s likely to affect your retail lease
No doubt you would have seen the recent headlines about how Inflation is growing at an alarming rate and now impacting the everyday cost of living. Anyone who has been to the supermarket recently or filled the tank of their vehicle, can attest to how high prices have been climbing recently.
So, what exactly is Inflation and how does it affect a retail business?
Inflation is where an economy experiences sustained high price increases that effectively reduce the purchasing power of a currency. What this means is you need more dollars to pay for the same goods and services that previously cost a lot less. Of course this puts immense pressure on consumers, unless they are receiving corresponding increases in wages and salaries. Unfortunately wages/salary growth has historically not kept pace with the rate of Inflation, so many households are really starting to feel the pinch.
Rising Inflation is generally not good for anyone (despite what some economic commentators say) particularly retailers who rely on the health of the consumer. The more a consumer has to spend on basic everyday needs such as electricity, fuel, gas, water, telecommunications and food, the less they have to spend on discretionary purchases, thereby impacting overall retail sales.
Aside from the obvious affect of weakening consumer demand, the average Cost Of Goods Sold (COGS) is increasing meaning the retailer will need to raise their sale price to try and maintain profit margins. This makes business even more challenging, as consumers are already pulling back on spending, so price increases will only exacerbate the problem.
Of course as a business owner, you will have your own operational expenses that will also be impacting your bottom line – costs such as Insurances, Electricity, Rent, Loan Repayments etc… will all be increasing, thus further eroding your profit. Eventually Inflation will find it’s way into wages/salaries, thus pushing up your operating expenses even more.
What about your lease, how will Inflation affect it? In most cases where a retailer is leasing commercial premises, they pay outgoings – these are effectively the combined statutory and running costs of maintaining the common areas of the building that your business sits in. These expenses encompass items such as council rates, land tax, water rates, insurances, air conditioning cleaning, security, repairs & maintenance and a bunch of other items. As Inflation continues to bite, most if not all of these costs will increase significantly, meaning that your proportion of Outgoings will also increase.There is another major impact of Inflation that may now start to seriously impact you as a retailer. If the base rent in your lease is geared to CPI (Consumer Price Index), it will increase significantly for the foreseeable future as any increases in Inflation are reflected in the CPI. As I am writing this article, the March 22 Quarter CPI All Groups Index for Australian Capital Cities has been released – compared to the March 21 Quarter, the increases are utterly staggering. The rises range from 4.4% for Sydney all the way up to 7.6% for Perth, so if your rent is based on movement of the CPI, you are facing massive increases depending upon which state/territory your business is located.
Some leases will be even more problematic as they are increased by CPI + 1%, 2% or 2.5% (or even higher). The result of this means that if for example you are based in WA and your lease states that your rent is to increase by CPI + 2% (based on the Perth All Groups Index – March 22 Qtr compared to March 21 Qtr) then, your rent will actually increase by 9.6% !
If you take into consideration all the increases in operating expenses and now outgoings and rent, total expenditure for your business is likely to rise dramatically. When you factor in weaker consumer demand (likely to result in lower sales), we are entering are a perfect storm.
So what can you do to combat this situation ?
Wages/salaries and rent are likely to be the two largest expenses of your business, so it’s important to really focus on these two areas. In terms of rent, if you have a lease on foot and it is geared to CPI, I would immediately talk to your landlord about not passing on the full extent of the increase, at least this year. I would try to negotiate perhaps halving the increase or maybe agreeing on a lower percentage.
If your lease is about to expire and you are starting to negotiate a new lease, I would try to fix the annual increases to say 2%, 3% or perhaps even 4% or 5% and avoid agreeing to any type of CPI increase. Your landlord might not agree to this, so maybe try for fixed percentage increases just for the first few years of the new lease term and CPI thereafter. We don’t how long this Inflation is going to last for – Central Banks in most developed economies maintain that Inflation is only transitory (ie. shouldn’t last too long), but I don’t believe they know for sure one way or another. I suspect Inflation is only going to get worse before it gets better and maybe protracted for some time yet.
Of course negotiating your new rent to the lowest possible level is going to be really critical, particularly if you want to remain in the same location and your landlord insists on CPI increases.
Try to think laterally – as with any new lease negotiation, I highly recommend that you look at considering alternate locations to relocate to (if possible), as a new landlord might be much more flexible with their asking rent and rent review mechanism.
I strongly believe that the months and years ahead are going to be very challenging from an Inflation standpoint, so it will be important to simply not accept the status quo. Regardless of what your lease states, if you are struggling with high rents and ballooning outgoings costs, I would try to negotiate some type of arrangement with your landlord. It will not be easy, however it is worth trying as the alternative could be much worse.
If you need assistance you should consider appointing a professional lease negotiator or solicitor to act on your behalf, as this will give you the best chance at improving your situation.